Bank of England boosts UK house prices as foreign buyers flood into central London

Last week saw new Bank of England governor, Mark Carney, follow the lead of US Fed Chairman Ben Bernanke on trying to deliver a ‘quick fix’ for the economy by boosting asset prices – particularly house prices and stock market levels.

But as the Bank of England chart shows, this means trying to return the ratio of house prices to earnings back to the levels seen in the bubble of 2003-2007. And we all know how that ended, with the near-collapse of the UK financial system:

The ratio of house prices to earnings is the basic measure of affordability

During the 1990s, it averaged around 4x, meaning the average price was 4 times average earnings

It then doubled to 8x during the bubble period, as central banks cut interest rates

The 2008 Crisis saw the ratio fall to 7x

But new government support means prices have since avoided the major declines seen elsewhere

Obviously this is good news for existing homeowners. But they are mainly older people, who are entering their low-spending years, and so their increased wealth is unlikely to stimulate much new consumer spending. Whilst younger people will have to pay more to buy a home. Today’s average price (£167k -$260k) is already 75% higher in real terms (adjusted for inflation) than during the 1990s according to Nationwide.

Consumer spending is 60% of UK GDP. So today’s high prices mean that younger people will have less money to spend on the discretionary products that drive consumer spending and chemical demand. So the policy will actually reduce overall economic growth rather than increase it. In addition, Carney’s attempt to further expand the house price bubble is already driving up interest rates – and so negating his promise last week to keep rates low.

A further concern is that today’s bubble is increasingly being driven (as in the US) by speculative money seeking to buy homes for rental purposes. Whilst average prices would probably already be much lower without the flood of money into central London housing from Asia, the Eurozone, Eastern Europe and the Middle East. Latest data, for example, shows nearly 75% of all new homes in central London were sold to foreign buyers in 2012.

As leading investor, and former EPCA speaker, Mark Faber has noted, one clear sign of a bubble top is when “condominium prices reach prices that exceed the purchasing power of the locals and are now advertised overseas”.

In the end, Carney and other Western policymakers will have to learn the lesson spelt out by former Bank of Japan governor, Masaaki Shirakawa, when he took office in 2008. He warned that fiscal stimulus and low interest rates make little difference over the longer-term, with Japan’s property prices falling a cumulative 60-80% as its bubble unwound post-1989.

Shirakawa’s uncomfortable lesson from Japan was that despite the hope of policymakers such as Carney and Bernanke, “the economy will have to grind out the excesses – high house prices and unsustainable household debt – that inflated the bubble in the first place”.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. He also serves as a Global Expert for the World Economic Forum. The aim of this blog is to share ideas about the influences that may shape the chemical industry and the global economy over the next 12 – 18 months. It looks behind today’s headlines, to understand what may happen next in critical areas such as oil prices, China and Emerging Markets, currencies, autos, housing, economic growth and the environment. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

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Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry.

The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such as oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts.

Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.